Taking the “Means Test” All the Way to Its End

If your income is higher than the median and you have too much disposable income, you’ll need “special circumstances” to do a Chapter 7.

  

The “Presumption of Abuse”

The means test determines whether you qualify to file a Chapter 7 “straight bankruptcy” case—or whether instead you have too much “means” to do so. If you don’t pass the means test, your case is said to be presumed to be an abuse of Chapter 7. That’s just another way of saying you are not legally appropriate for this type of bankruptcy relief. Then you can’t proceed with your Chapter 7 bankruptcy case, and your case will either be dismissed (thrown out) or more likely converted into a Chapter 13 “adjustment of debts” type of bankruptcy instead.

There are a number of levels to this test. Once you pass it at any of the levels, you don’t have to go any further. My last few blog posts explored the earlier levels; today is about the final level. You only get here if you haven’t passed the means test on any of the earlier levels.

The Earlier Levels of the Means Test

You can avoid this presumption of abuse IF ANY of the following apply to you:

First, your income is no more than the median family income for your state and your size of family. See this website for the current median income amounts. Caution: “income” has a very specific and unusual definition for means test purposes. See my recent blog posts for more about this.

Second, if your income is more than the applicable median family income amount but, after subtracting a list of allowable expenses, your remaining monthly disposable income is less than about $125 per month, then you pass the means test.

Third, if your income is more than the applicable median family income amount, AND your remaining monthly disposable income after the allowable expenses is more than about $125 per month but no more than about $208 per month, then you may be able to still pass the means test. But that’s only if, when you multiply your monthly disposable income amount by 60, that total is less than 25% of your “non-priority unsecured debts” (debts not secured by collateral, excluding special “priority debts”—certain taxes, support payments, and such).

It’s somewhat rare that a person who needs and wants to file a Chapter 7 case would not have passed the means test through one of the above levels. A large percentage of people pass on the first level by simply having low enough income. Others pass at the second level because their income is low enough compared to their expenses. And others pass because the amount of their disposable income after expenses is low enough compared to the amount of their debt.

The Last Level

BUT, if after all this you haven’t passed the means test that your case is still under a presumption of abuse, you still have one more last chance, one last level of the means test to pass. You can show “special circumstances.” The Bankruptcy Code lays out this out as follows:

[T]he presumption of abuse may… be rebutted by demonstrating special circumstances, such as a serious medical condition or a call or order to active duty in the Armed Forces, to the extent such special circumstances… justify additional expenses or adjustments of current monthly income for which there is no reasonable alternative.

Congress did not make clear what counts for “special circumstances” beyond the two examples provided.

The Means Test Ends Up Being Not So “Objective”

So when pushed to the last level, a test that was intended to be an objective way to decide who qualifies to file a Chapter 7 bankruptcy comes down to a very subjective question about whether any “special circumstances” apply. Talk to your attorney about how this phrase is being interpreted in your local bankruptcy court.

 

/by

The “Means Test” Tries to Be Objective

The point of the “means test” is to objectively judge whether you have the means to pay your creditors. But this test is very arbitrary.

 

As we explained in last week’s blog post, the “means test” is supposed to be an objective way to decide who qualifies to file a Chapter 7 bankruptcy. That decision used to be more in the hands of bankruptcy judges, who were apparently seen as being too lenient with debtors (which is odd because the majority of the judges are former creditor attorneys!).

The “Objective” Rule

As also discussed in the last blog post, there is a very specific formula for determining if you can do a Chapter 7 case: if your budget shows that you have some money left over each month—some “disposable income”—it all depends on its amount and how it compares to the amount of your debts. This is how “objective” this rule is:

  1. If your “monthly disposable income” is less than $125, then you pass the means test and qualify for Chapter 7.
  2. If your “monthly disposable income” is between $125 and $208, then you go a step further: multiply that “disposable income” amount by 60, and compare that to the total amount of your regular (not “priority”) unsecured debts. If that multiplied “disposable income” amount is less than 25% of those debts, then you still pass the “means test” and qualify for Chapter 7.
  3. If EITHER you can pay 25% or more of those debts, OR if your “monthly disposable income” is $208 or more, then you do NOT pass the means test. BUT you still might be able to do a Chapter 7 case IF you can show “special circumstances,” such as “a serious medical condition or a call or order to active duty in the Armed Forces.”

Where Do Those Crucial Amounts—$125 and $208—Come From?

Notice the huge difference in effect of these numbers. If you have less than $125 to spare, you are “presumed” to qualify for Chapter 7; if you have more than $208 to spare, you are
“presumed” to not qualify for Chapter 7, unless you can show “special circumstances.” And if you have an amount in between, then you must apply that 25% extra condition.

That’s a huge difference in consequences for a spread of only $83 per month.

So where do these hugely important numbers come from?  The Bankruptcy Code actually refers to those numbers multiplied by 60—$7,475 and $12,475. When the law was originally passed in 2005 these amounts were actually $6,000 and $10,000 (therefore, $100 and $167 monthly), but they have been adjusted for inflation since then.

So where did those original $6,000 and $10,000 amounts come from?

They are arbitrary. Why was anything less than $6,000 (now $7,475) considered low enough to allow a Chapter 7 to proceed, while anything more than $10,000 (now $12,475) was considered high enough to not allow it? Some creditor lobbyist or Congressional staffer likely just came up with those numbers, and maybe they were negotiated in Congress. In any event, somewhere in the process Congress decided that it needed to use certain numbers, and those are the ones that made it into the legislation. It’s the law, regardless that there doesn’t seem to be any real principled reason for using those amounts in determining whether a person should or shouldn’t be allowed to file a Chapter 7 case.

The Bottom Line

Sensible or not (and there is a lot in the “means test” which is not!), if your income is under the published median income amount, then you pass the “means test” and can proceed under Chapter 7 (see our earlier blog about that). But if you are over the median income amount, then the amount of your “monthly disposable income” largely determines whether you are able to file a Chapter 7 case. (Remember that most people needing a Chapter 7 case qualify easily by having low enough income, skipping the complications covered in today’s blog post.)

 

/by

The Expenses Step of the Chapter 7 “Means Test”

If your income is higher than “median income,” you may still file a Chapter 7 case by going through the expenses step of the means test.

 

The Easy, Income Step of the Means Test

The last couple of blog posts have covered the first step of the means test, the income step. It says that if your “income”—as that term is uniquely defined in this law—is no more than the published median amount for your state of residence and for your size of family, you can skip the rest of the means test, and you generally qualify for a Chapter 7 “straight bankruptcy” case. You don’t have to go through the rest of the means test.

The Admittedly Complicated, Expenses Step of the Means Test

If on the other hand your “income” is greater than the median income amount applicable to your state and family size, then you have to go through the detailed expenses step to see whether you can participate in a Chapter 7 case.

The Challenge of the Means Test

The concept behind the means test is pretty straightforward: people who have the means to pay a meaningful amount to their creditors over a reasonable period of time should be required to do so. But putting that concept into law resulted in an amazingly complicated set of rules.

These expense rules are detailed and rigid because Congress was trying to be objective. The assumption was debtors would just inflate their anticipated expenses to show that they had no money left over for their creditors—no “means” to pay them anything.

One of the complications is that the allowed expenses include some based on your stated actual expense amounts, while others are based on standard amounts. The standard amounts are based on Internal Revenue Service tables of expenses, but some of those standards are national, some vary by state, and some even vary among specific metropolitan areas within a state. There are even some expenses which are partly standard and partly actual (certain components of transportation expenses).

There are also rules about when to allow and how to determine the allowed amounts for secured debt payments (vehicle, mortgage) and for “priority debts” (income taxes, accrued child support).

If You Have Disposable Income

After all that, if after subtracting all the allowed expenses from your “income” you have some money left over, whether you can be in Chapter 7 depends on the amount of that money and how that compares to the amount of your debts:

  1. If the amount left over—the “monthly disposable income”—is no more than $125, then you still pass the means test and qualify for Chapter 7.
  2. If your “monthly disposable income” is between $125 and $208, then apply the following formula: multiply that amount by 60, and compare that to the total amount of your regular (not “priority”) unsecured debts. If the multiplied total is less than 25% of those debts, then you still pass the means test and qualify for Chapter 7.
  3. If after applying the above formula you can pay 25% or more of those debts, OR if your “monthly disposable income” is more than $208, then you do NOT pass the means test, UNLESS you can show “special circumstances,” such as “a serious medical condition or a call or order to active duty in the Armed Forces.”

THAT’s Complicated!

True enough. So you certainly want to have an attorney who fully understands these often confounding rules and how they are being interpreted by the local bankruptcy judges and the pertinent appeals courts.

If you don’t pass the means test you will instead likely end up in a 3-to-5-year Chapter 13 case. Not only would that mean getting full relief from your debts years later than under Chapter 7, with a similar delay in rebuilding your credit, you may well also end up paying thousands, or even tens of thousands, more dollars to your creditors. It’s definitely worth going through the effort to find a competent bankruptcy attorney to help you, whenever possible, find a way to pass the means test. 

 

/by

Taking Advantage of the Rigidity of the Chapter 7 “Means Test”

Because of how precisely the amount of your “income” is calculated, filing bankruptcy just a day or two later can make all the difference.

 

Passing the “Means Test”

Our last blog post was about most people passing the “means test” by making no more than the median income for their state and family size. We also made clear that “income” for this purpose has a very broad meaning, by including non-taxable received from irregular sources such as child and spousal support payments, insurance settlements, cash gifts from relatives, and unemployment benefits. Also, we showed how time-sensitive the “means test” definition of “income” is in that it is based on the amount of money received during precisely the 6 FULL CALENDAR months before the date of filing. This means that your “income” can shift by waiting just a month or two, or even by waiting just a few days until the turn of the month (since that changes which 6 months of income is at issue).

Why is the Definition of “Income” for the “Means Test” So Rigid?

One of the much-touted goals of the last major amendments to the bankruptcy law in 2005 was to prevent people from filing Chapter 7 who were considered not deserving. The most direct means to that end was to try to force more people to pay a portion of their debts through Chapter 13 “adjustment of debts” instead of writing them off Chapter 7 “straight bankruptcy.”

The primary tool intended to accomplish this is the “means test,” Its rationale was that instead of allowing judges to decide who was abusing the bankruptcy system, a rigid financial test would determine who had the “means” to pay a meaningful amount to their creditors in a Chapter 13 case, and therefore could not file a Chapter 7 case.

The Unintended Consequences of the “Means Test”

The last blog post explained the first part of the means test: comparing the income and money you received from virtually all sources during the six full calendar months before filing bankruptcy to a standard median income amount for your state and your family size. If your income is at or under the applicable median income, then you generally get to file a Chapter 7 case. If your income is higher than the median amount, you may still be able to file a Chapter 7 case but you have to jump through a whole bunch of extra hoops to do so. Having income below the median income amount makes qualifying for Chapter 7 much simpler and less risky.

Filing your case a day earlier or later can matter so much because of the means test’s fixation on the six prior full calendar months, AND because you include ALL income during that precise period (other than social security). 

So if you receive some irregular chunk of money, that can push you over your applicable median income amount, and jeopardize your ability to qualify for Chapter 7.  

An Example

It does not necessarily take a large irregular chunk of money to make this difference, especially if your income without that is already close to the median income amount. An income tax refund, some catch-up child support payments, or an insurance settlement or reimbursement could be enough. 

Imagine having received $3,000 from one of these sources on October 15 of last year. Your only other income is from your job, where make a $42,000 salary, or $3,500 gross per month. Let’s assume the median annual income for your state and family size is $45,000.

So imagine that now in the early part of April 2014, your Chapter 7 bankruptcy paperwork is ready to file, and you would like to get it filed to get protection from your aggressive creditors. If your case is filed on or before April 30, then the last six full calendar month period would be from October 1, 2013 through March 31, 2014. That period includes that $3,000 extra money you received in mid-October. Your work income of 6 times $3,500 equals $21,000, plus the extra $3,000 received, totals $24,000 received during that 6-month period. Multiply that by 2 for the annual amount—$48,000. Since that’s larger than the applicable $45,000 median income, you would have failed the income portion of the “means test.”

But if you just wait to file until May 1, then the applicable 6-month period jumps forward by one full month to the period from November 1 of last year through April 30 of this year. Now that new period no longer includes the $3,000 you received in mid-October. So now your income during the 6-month period is $21,000, multiplied by 2 is $42,000. This results in your income being less than the $45,000 median income amount. You’ve now passed the “means test,” and qualified for Chapter 7. 

 

/by

The Easiest Way to Pass the Chapter 7 “Means Test”

Most people considering Chapter 7 “straight bankruptcy” have low enough income to qualify.  Find out if you do.

 

The “Means” Part of the “Means Test”

When Congress passed the last major set of changes to the bankruptcy laws nine years ago, it explicitly said that wanted to make it harder for some people to file Chapter 7.  The idea was that those who have the means to pay a significant amount of their debts should do so. Specifically, those who can pay a certain amount to their creditors within a three-to-five-year Chapter 13 payment plan ought to do so, instead of just being able to write off all their debts in a Chapter 7 case.

How the Law Determines Whether You Have Too Much “Means”

The “means test” measures people’s “means” in a peculiar, two-part way, the first part based on income, the second part based on expenses.

The income part is relatively straightforward; the expense part involves an amazingly complicated formula of allowed expenses.

The good news is that if your income is low enough on the income part of the “means test,” then you’re done: you’ve passed the test and can skip the rest of the test. The other good news is that most people who want to file a Chapter 7 case DO have low enough income so that they do pass the “means test” based simply on their income.

Is YOUR Income Low Enough to Pass the “Means Test”?

Your income is low enough if it is no higher than the published “median income” for a household of your size in your state. You can look at your “median income” on this website (for bankruptcy cases filed on or after April 1, 2014).

A Peculiar Definition of “Income”

Here’s what you need to know to compare your “income” (as used for this purpose) to the “median income” applicable to your state and family size:

1. Determine the exact amount of “income” you received during the SIX FULL calendar months before your bankruptcy case is filed. It’s easiest to explain this by example: if your Chapter 7 case is filed on March 25, 2014, count every dollar you received during the six-month period from September1, 2013 through February 28, 2014. After coming up with that six-month total, divide it by six for the monthly average.

2.When adding up your “income” include all that you’ve acquired from all sources during that six-month period of time, including unconventional sources like child and spousal support payments, insurance settlements, unemployment benefits, and bonuses. But EXCLUDE any income from Social Security.

3. Multiply your six-month average monthly income by 12 for your annual income. Compare that amount to the published median income for your state and your size of family in the link provided above. (Make sure you’re using the current table.)

Conclusion

If your “income”—calculated in the precise way detailed here—is no more than the median income for your state and family size, then you have passed the “means test” and can file a Chapter 7 case.

But if your income is higher than that, you may still be able to pass the “means test” and file a Chapter 7 case. That’s covered in the next blog post.  

 

/by

Why You Should or Should Not Worry about Creditors Objecting in Your Bankruptcy Case

FACT: In bankruptcy, creditors seldom fight the write-off of their debts. Why not? And when DO they tend to fight?

 

Debts That Creditors Must Object To

This blog post is NOT about the kinds of debts that simply can’t be discharged (legally written off), and don’t need the creditor to object for that to happen. Examples of those are child and spousal support obligations, recent income taxes debts, and criminal fines. Those survive bankruptcy without any effect on them.

Instead this is about ordinary debts and the ability of any creditor to raise certain limited kinds of objections to the discharge of its debt.

Your Fears

As you consider whether or not to file bankruptcy, you might be wondering whether doing so would be effective—whether you will succeed in discharging your debts so you no longer have to pay them. And you might also wonder whether it would be emotionally difficult—whether the creditors would give you a bad time and try to make you feel guilty for not paying your debts.

As indicated at the beginning of this blog post, creditors will very seldom raise objections to discharging their debts. So your bankruptcy case will likely result in the discharge of all the debts you expect to discharge, usually without even hearing from most or all of your creditors about it. So your bankruptcy will in most cases be effective and not contentious.

Why Objections Aren’t Usually Raised

But if creditors have a right to object, why don’t they do so? If they can make trouble for you, why don’t they?

Simply because doing so is very seldom worth their trouble.

Why not?

1. Creditors seldom have the factual basis on which to object.

The legal grounds for creditors to object to the discharge of their debts are quite narrow. They need to present evidence that you incurred the debt through fraud or misrepresentation, by theft or embezzlement, by your intentional injury to a person’s body or property, or through some other similar bad act. The biggest reason that creditors don’t raise objections to the discharge of their debts is that they seldom have grounds to do so.

2. It takes money for creditors to object, money they may well not recoup.

Creditors sometimes do have factual grounds to object, for example in relatively common situations such as bounced checks or the use of credit without the intent to repay (just before filing bankruptcy). But even in these situations, creditors often don’t object because they decide it’s not worth the risk that they would just spend more money on objecting without doing any good. They often don’t want to risk spending more money to pay for their staff and for attorney fees only to have the bankruptcy judge decide that the required grounds for objection have not been met.

3. The risk that the creditor would have to pay your attorney fees.

One of the reasons why sensible creditors decide not to object unless they are very confident that they have the grounds to do so is that they risk being ordered to pay your attorney’s fees for defending against their objection. That would happen if the judge decided that “the position of the creditor was not substantially justified.” So if creditors are not very confident of their argument, they could be dissuaded further by the risk of having to pay your costs fighting the objection.

So that’s why most creditors just write off the debt and you hear nothing from them during your bankruptcy case.

When Creditors Tend to Object

Creditors do object sometimes, often involving one of the following two situations:

1. Using leverage against you.

If a creditor thinks it has a sensible case against you, it could raise an objection knowing that you are not willing or able to pay a lot of attorney fees to fight it. The creditor knows that even if you have a good defense to its accusations so that you could well win if the matter went all the way to trial, it would cost you a lot to get to that point. So they raise the objection in hopes of inducing you to enter into a settlement quickly.

2. A Personal Grudge

If a creditor is very angry at you for some reason, he, she, or it might be looking for an excuse to harm you or cause you problems. Ex-spouses and ex-business partners are the most common creditors of this sort, but sometimes more conventional creditors find some reason to pick on you. Irrationality is unpredictable, so it sometime drives an objection even when there are little or no factual grounds for it.

The Creditors’ Firm Deadline to Object

Creditors have a very limited time to raise objections: their deadline is only 60 days after the Meeting of Creditors (so around 3 months after your bankruptcy case is filed).

So, talk with your attorney if you have any concerns along these lines. And then if whatever assurances he or she gives you doesn’t stop you from worrying about this, you’ll at least know that you won’t have long to worry before the creditors’ right to object expires. 

 

/by

When Chapter 7 “Straight Bankruptcy” is Not So Straightforward

How can you tell if your Chapter 7 case will be straightforward? Avoid 4 problems.

 

Most Chapter 7 cases ARE straightforward. Your bankruptcy documents are prepared by your attorney and filed at court, about a month later you go to a simple 10-minute hearing with your attorney, and then two more months later your debts are discharged—written off. There’s a lot going on behind the scenes but that’s usually the gist of it.

But some cases ARE more complicated. How can you tell if your case will likely be straightforward or instead will be one of the relatively few more complicated ones?

The four main problem areas are: 1) income, 2) assets, 3) creditor challenges, and 4) trustee challenges.

1) Income

Most people filing under Chapter 7 have less income than the median income amounts for their state and family size. That enables them to easily pass the “means test.” But if instead you made or received too much money during the precise period of 6 full calendar months before your case is filed, you can be disqualified from Chapter 7. Or you may have to jump through some more complicated steps to establish that you are not “abusing” Chapter 7. Otherwise you could be forced into a 3-to-5 year Chapter 13 case or your case could be dismissed—thrown out of court. These results can sometimes be avoided with careful timing of your case, or even by making change to your income before filing.

2) Assets

Under Chapter 7 if you have an asset which is not protected (“exempt”), the Chapter 7 trustee can take and sell that asset, and pay the proceeds to the creditors. You may be willing to surrender a particular asset you don’t need in return for the discharge of your debts. That could especially be true if the trustee would use those proceeds in part to pay a debt that you want and need to be paid anyway, such as back payments of child support or income taxes. Or you may want to pay off the trustee through monthly payments in return for the privilege of keeping that asset. In these “asset” scenarios, there are complications not present in the more common “no asset” cases.

3) Creditor Challenges to the Dischargeability of a Debt

Creditors have a limited right to raise objections to the discharge of their individual debts. This is limited to grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. With most of these, the creditor must raise such objections to dischargeability within about three months of the filing of your Chapter 7 case—precisely 60 days after your “Meeting of Creditors.” Once that deadline passes your creditors can no longer complain, assuming that they received notice of your bankruptcy case.

4) Trustee Challenges to the Discharge of All Debts

In rare circumstances, such as if you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the trustee’s Meeting of Creditors, or if you don’t cooperate with the trustee’s review of your financial circumstances, you could possibly lose the right to discharge any of your debts. The bankruptcy system largely relies on the honesty and accuracy of debtors. So it is quite harsh towards those who abuse the system through deceit.

No Surprises

Most of the time, Chapter 7s are straightforward. The most important thing you can do towards that end is to be completely honest and thorough with your attorney during your meetings and through the information and documents you provide. That way you will find out if there are likely to be any complications, and if so whether they can be avoided, or, if not, how they can be addressed in the best way possible. 

 

/by

Major Advantages of Chapter 13 “Adjustment of Debts”

Chapter 7 “straight bankruptcy” is quick and often gives you what you need. But in many situations, Chapter 13 gives you SO much more.

 

The last blog post showed how a simple Chapter 13 case works. That example illustrated one of the special advantages you get with Chapter 13: if you have a debt which can’t be discharged (legally written off) in a regular Chapter 7 case—such as a recent IRS income tax debt or back child support—these kinds of special debts can be conveniently paid over time through a Chapter 13 payment plan. The crucial advantage here is that throughout the 3-to-5-year plan such creditors can’t take any collection action against you or your assets.

That’s just the first major way that Chapter 13 buys time and protection that Chapter 7 simply cannot provide. Here are some of the other main advantages of Chapter 13:

1. You can keep your possessions that are not protected by property “exemptions,” preventing a Chapter 7 trustee from taking them from you. Thus you retain much more control over the process of saving your assets, avoiding the unknowns of negotiating payment terms with a Chapter 7 trustee in order to keep your non-exempt possessions. Also, in a Chapter 13 case, you have 3 to 5 years to pay to protect such possessions, instead of the few months that Chapter 7 trustees generally allow.

2. Similarly, if you fell behind in payments on your home’s first mortgage, you have the length of your plan—the same 3 to 5 years–to catch up. That’s in contrast to the few months of payments that a mortgage lender would generally allow if you negotiated directly with it after filing a Chapter 7 case.

3. You may be able to “strip” a second (or third) mortgage from your home’s title, and avoid paying all or most of that mortgage. This can happen if the value of your home is less than the balance of your first mortgage. Mortgage “stripping” may save you hundreds of dollars per month and potentially many tens of thousands of dollars over time. This is completely unavailable in a Chapter 7 case.

4. You may be eligible for “cramdown” of your vehicle loan. If you purchased and financed your vehicle more than two and a half years before filing your Chapter 13 case, and the vehicle is worth less than the balance on the loan, your monthly payments and the total amount you pay for your vehicle can be significantly reduced. This could enable you to keep a car or truck that you couldn’t otherwise. In contrast, in a Chapter 7 straight bankruptcy case you are usually almost always stuck with the monthly payment and loan balance dictated by the vehicle loan contract.

5. In that same situation, if you are behind on the vehicle loan payments you don’t have to catch up those back payments. In a Chapter 7 case, almost always you must quickly pay off any arrearage if you want to keep the vehicle.

6. If you owe an ex-spouse non-support obligations, you can discharge (write-off) them under Chapter 13—not under Chapter 7. Non-support obligations include requirements in a divorce decree to pay off a joint marital debt or to pay the ex-spouse in return for getting more of the marital property. Discharging such debts can make a huge difference, often making Chapter 13 well worthwhile.

7. If you have any student loans, under Chapter 13 you could likely delay paying on them for three years or more. That can be especially helpful if you have some other debts that are essential to pay off during your case (like child support arrearage or recent income taxes). Also, if you have a worsening medical condition, you may be better situated to qualify for a “hardship discharge” of your student loans if you wait until later in your Chapter 13 case.

People often assume they need and want a regular Chapter 7 bankruptcy, and it’s often exactly what they do need. But the above short list gives you some idea of the benefits of Chapter 13 that may make it a much better option. That’s one of the reasons you should talk with an experienced bankruptcy attorney, and do so with an open mind. That’s because sometimes Chapter 13 can give you a huge unexpected advantage, or a series of smaller advantages, which may swing your decision in that direction. 

 

/by

What a Simple Chapter 13 Case Looks Like

The most common reason for a Chapter 13 “adjustment of debts” is if you have debts that can’t be written off in a “straight” Chapter 7 case.

 

When Chapter 7 Does Not Discharge Your Debts

My last blog post was about the discharge (legal write-off) of debts under Chapter 7. I concluded with the comment that if you have debts that Chapter 7 doesn’t discharge, Chapter 13 may be the way to go. It provides what is often the safest and most convenient method to deal with debts that you have to pay, while also discharging those debts that would be discharged under Chapter 7. The much longer time that Chapter 13 takes—3 to 5 years instead of as short as 3 to 4 months for most Chapter 7 cases—can be highly worthwhile under the right circumstances.

An Example

Let’s show you one example of the right circumstances. Imagine someone owing $7,000 in IRS debt for 2011 and 2012, $3,000 in back child support, $20,000 in credit cards, and $5,000 in medical bills. The person lost his or her job in late 2010 and used the situation to try to run a one-person business during 2011 and 2012. It made a little money but only barely enough to pay living expenses. There was absolutely no money available to set aside for income taxes. During that period the person also fell behind on child support payments. Then this person found a new job a few months ago that pays less than the one lost in 2010, but at least enough to pay ongoing taxes and support, in addition to living expenses. But the person’s budget leaves only about $400 to pay ALL debts, not nearly enough to pay the minimum amounts on the credit cards, much less anything towards the rest of the debts including the taxes and back support.

What Chapter 7 Would and Would NOT Accomplish

A regular Chapter 7 case would likely discharge the $20,000 in credit cards and the $5,000 in medical bills, but would leave owing the $7,000 to the IRS and the $3,000 in back support. Although discharging $25,000, the person would come out of bankruptcy still $10,000 in debt, owed to two creditors who can be extremely aggressive—the IRS and your ex-spouse or the local support enforcement agency.

Although the IRS might be willing to accept payments of $400 per month, there’s a good chance that your ex-spouse or the support enforcement agency would be able to garnish your wages for the back support, and that would negate any possible arrangement with the IRS. Plus the last thing this person would want at his or her new job is for the payroll office to get a garnishment order for back child support. A previously filed Chapter 7 case would have no power to stop that kind of garnishment.

What Chapter 13 Would Accomplish

In contrast Chapter 13 would be able to stop your ex-spouse or support agency from garnishing for back support—as well as from any action the IRS or any state taxing entity, or virtually any other creditor, could take.

So the person in our example would file a Chapter 13 case, start or continue paying any ongoing monthly child support payments, and would also be sure to have withheld an adequate amount for ongoing income taxes. Then his or her attorney would put together a plan to pay the Chapter 13 trustee $400 per month (based on what is available in his or her budget) for 36 months.

During that period of time neither the IRS, nor the support agency or ex-spouse, nor any other creditors would be able to take any action against the person or any of his or her assets as long as he or she complied with the Chapter 13 plan. That means that he or she kept up the $400 plan payments, and kept current on ongoing tax and support obligations (as provided for in the budget).

Over those three years the trustee would be paid $14,400 ($400 X 36 months), which would pay all the $3,000 in back support and the $7,000 in taxes—usually without any additional interest or penalties from the date of the filing of the Chapter 13 case. The Chapter 13 trustee would also get paid, usually about 5-to-10% of what is being paid into the plan, as would any attorney fees that weren’t paid to the attorney at the beginning of your case.  If there would be any money left over (little or none in this example), that would be divided pro rata among the credit card and medical debts. After the 36 months of payments, any remaining balances on those debts would be discharged. That would leave the person at the end of the Chapter 13 case owing nothing to anyone. The back taxes and support would have been paid off, and he or she would be current on any ongoing income taxes and child support.

So that’s what a simple Chapter 13 case would accomplish and would look like. 

 

/by

Discharge of Your Debts: THE Goal of Bankruptcy

Most debts are “discharged”—written off—in bankruptcy. But some may not be. Can we know in advance which will and will not be discharged?

 

 

Bankruptcy is about Discharge

The point of bankruptcy is to get you a fresh financial start through the legal discharge of your debts.

Both kinds of consumer bankruptcy—Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts”—can discharge debts. But most Chapter 13s tend to have other purposes as well, and the discharge usually occurs only 3 to 5 years after the case is filed.

In contrast, most Chapter 7 cases are filed for the single, or at least primary, purpose of discharging debts. Furthermore, in most Chapter 7 cases all debts that the debtors want to discharge are in fact discharged, and this happens within just three months or so after the case is filed.

This blog post focuses on Chapter 7 discharge of debts.

What Debts Get Discharged?

Is there a simple way of knowing what debts will and will not be discharged in a Chapter 7 case?

Yes and no.

We CAN give you a list of the categories of debts that can’t, or might not, be discharged (see below). But some of those categories are not always clear which situations they include and which they don’t. Sometimes whether a debt is discharged or not depends on whether the creditor challenges the discharge of the debt, on how hard it fights for this, and then on how a judge might rule.

Why Can’t It Be Simpler?

Laws in general are often not straightforward, both because life can get complicated and because laws are usually compromises between competing interests. Bankruptcy laws, and those about which debts can be discharged, are the result of a constant political tug of war between creditors and debtors over the last few centuries. There have been lots of compromises, which has resulted in a bunch of hair-splitting laws. 

To give some perspective, believe it or not the original bankruptcy laws in England—from which our bankruptcy laws came—did not include ANY discharge of debts. Bankruptcy was originally designed as a procedure to help creditors collect from debtors, not at all as a legal means of protecting debtors from creditors. So there was no perceived need for a discharge of debts—the creditors could just continue chasing their debtors after the bankruptcy procedure was done!

But Let’s Get Practical

The present reality is much more positive, and usually pretty straightforward:

#1:  All debts are discharged, EXCEPT those that fit within a specified exception.

#2:  There are quite a few of exceptions, and they may sound like they exclude many kinds of debts from being discharged. It may also seem like it’s hard to know if you will be able to discharge all your debts. But it’s almost always much easier than all that. As long as you are thorough and candid with your attorney, he or she will almost always be able to tell you whether you have any debts that will not, or may not, be discharged. Most of the time there are no surprises.

#3:  Some types of debts are never discharged. Examples are child or spousal support, criminal fines and fees, and withholding taxes.

#4:  Some other types of debts are never discharged, but only if the debt at issue fits certain conditions. An example is income tax, with the discharge of a particular tax debt depending on conditions like how long ago those taxes were due and when its tax return was received by the taxing authority.

#5:  Some debts are discharged, unless timely challenged by the creditor, followed by a judge’s ruling that the debt met certain conditions involving fraud, misrepresentation, larceny, embezzlement, or intentional injury to person or property.

#6:  A few debts can’t be discharged in Chapter 7, BUT can be in Chapter 13. An example is an obligation arising out of a divorce other than support (which  can never be discharged).

The Bottom Line

#1: For most people the debts they want to discharge WILL be discharged. #2: An experienced bankruptcy attorney will usually be able to predict whether all of your debts will be discharged. #3: If you have debts that can’t be discharged, Chapter 13 is often a decent way to keep those under control. More about that in my next blog post about Chapter 13.

 

/by